University of San Jose – Recoletos

College of Commerce
Accountancy and Finance Department

Accounting 106: Valuation Concepts

Mr. Jun Brian Alenton, CPA, CMA, CAT, RCA, MICB

ACCOUNTING FOR DERIVATIVES

(PFRS 9)
PROBLEM NO. 1 (Forward – Fair Value Hedge)
EVILNESS CORPORATION, a Filipino company, enters into a forward exchange contract on October 1, 2020 to hedge a
foreign currency risk export for $100,000 in US dollars. The contract is for the sale of $100,000 to the international
bank for delivery on March 31, 2021. The company anticipates the dollar will weaken against the peso.
Relevant exchange rates for the US dollars are as follows:
10/01/20 12/31/20 03/31/21
Spot rate P46.35 P46.00 P45.60
30-day forward 46.25 45.50 46.00
90-day forward 46.28 45.80 45.60
180-day forward 46.30 43.60 45.00

Required: Reconstruct all journal entries for the foreign currency transaction and the forward contract in the books of
EVILNESS based on the assumption that Fair value of forward contracts is based on forward rates.

October 1, 2020
To record the change in FV of derivative ( Forward
To record the exportation transaction (Spot Rate) Rate for the remaining term)
Accounts Receivable P4,635,000 Derivative asset-FC P50,000*
Sales P4,635,000* Forex Gain (P/L) P50,000

*[100,000 x 46.35] *[100,000 x (P46.30 – P45.80)]

Remember that is the HEDGED ITEM is an Or
EXPORTATION or IMPORTATION, measure it using Forward Contract Receivable (Fixed) P4,630,000
SPOT rates always. Forward Contract Payable (In Dollars) 4,580,000
Fair Value of Forward Contract - Assets 50,000
To record the forward contract (Forward Rate based on
full term)
March 31, 2021
Memo entry only because no fair value is zero:
To record receipt from exportation (SPOT RATE)
Forward Contract Receivable (Fixed) P4,630,000
Forward Contract Payable (Dollars) 4,630,000 Cash P4,560,000
Fair Value of Forward Contract 0 Forex Loss 40,000 *
Accounts Receivable P4,600,000
Which one (Receivable or Payable) should be fixed in
pesos and which one should be in foreign currency? The (46.00 – 45.60) x 100,000 = 40,000 loss
one that is expected to be received or paid in FOREIGN
CURRENCIES (or dependent on the value of an item per To record settlement of Forward Contract (Spot Rate)
measurement date) will change in value each reporting Cash (Received From FC) P70,000
period. While the one that is expected to be paid in PHP Derivative asset-FC P50,000
will be fixed until the end. The difference in the value Forex Gain 20,000 *
will be recognized as the FAIR VALUE of the derivative.
*[100,000 x (P45.80 – P45.60)] = 20,000 gain
December 31, 2020

To record the change in the value of receivable (SPOT Forward Contract Receivable (Fixed) P4,630,000
RATE) Forward Contract Payable (In Dollars) 4,560,000
Forex Loss (P/L) P35,000* Fair Value of Forward Contract - Assets 70,000
Accounts Receivable P35,000

(46.00 – 46.35) x 100,000 = 35,000 loss

PROBLEM NO. 2 (Forward – Cash Flow Hedge)

Hermosa Company operates a chain of exotic restaurants. On January 1, 2020, Hermosa determined that it will need
to purchase 100,000 kilos of an exotic fish on January 1, 2021. On January 1, 2020, because of the volatile fluctuation
in the price of exotic fish, Hermosa negotiated a forward contract with Weird Bank to purchase 100,000 kilos of exotic
fish on January 1, 2021 at a price of P50 per kilo or 5,000,000. On December 31, 2020, and January 1, 2021, the
prevailing market price for fish is P60 per kilo. Hermosa purchases the exotic fish and settles the forward contract on
January 1, 2021.

ACCTG 106 PFRS 9: DERIVATIVES AND HEDGING Page 1 of 9

REQUIRED:
1. Prepare the necessary entries on Hermosa’s books at
(a) January 1, 2020
(b) December 31, 2020
(c) January 1, 2021

2. Assuming that the prevailing market price is P45 per kilo on December 31, 2020, and January 1, 2021, prepare the
necessary entries on Hermosa’s books at
(a) January 1, 2020
(b) December 31, 2020
(c) January 1, 2021

SOLUTION:

REQUIREMENT NO. 1 FV adjustment G/L-FC P1,000,000

Fish inventory P1,000,000
January 1, 2020
REQUIREMENT NO. 2
To record the forward contract
January 1, 2020
Memo entry
To record the forward contract
December 31, 2020 Memo entry

To record the change in FV of derivative December 31, 2020

Derivative asset-FC P1,000,000*
FV adjustment G/L-FC (OCI) P1,000,000 To record the change in FV of derivative
FV adjustment G/L-FC (OCI) P500,000
*[100,000 x (P60 – P50)]
Derivative liability-FC P500,000
January 1, 2021
To record the purchase of fish January 1, 2021
Fish inventory (100T x P60) P6,000,000 To record the purchase of fish
Cash P6,000,000
Fish inventory P4.5M
Cash P4.5M
To record receipt from counterparty
Cash P1,000,000 To record payment to counterparty
Derivative asset-FC P1,000,000
Derivative liability-FC P500,000
Cash P500,000
To record reclassification adjustment
FV adjustment G/L-FC (OCI) P1,000,000 To record reclassification adjustment
Cost of sales (P/L) P1,000,000
Cost of sales (P/L) P500,000
FV adjustment G/L-FC (OCI) P500,000
Alternative journal entry (As a matter of policy)

PROBLEM NO. 3 (Interest Rate Swap – Cash Flow Hedge)

On January 1, 2020, Bataan Ventures, Inc., received a three-year, P1 million loan with interest payments due at the
end of each year and the principal to be repaid on December 31, 2022. The interest rate for the first year is the
prevailing market rate of 9 percent, and the rate each succeeding year will be equal to the prevailing market rate on
January 1 of that year. Bataan also entered into an interest rate swap agreement related to this loan. Under the terms
of the swap agreement, in the years 2021 and 2022, Bataan will receive a swap payment based on the principal amount
of P1 million. If the January 1 interest rate is greater than 9 percent, Bataan will receive a swap payment for the
difference; and if the January 1 interest rate is less than 9 percent, Bataan will make a swap payment for the difference.
The swap payments are made on December 31 of each year. On January 1, 2021, the interest rate is 8 percent, and
on January 1, 2022, the interest rate is 12 percent.

REQUIRED:
Prepare all the journal entries necessary on Bataan's books at the dates shown below. For purposes of estimating future
swap payments, assume that the current interest rate is the best forecast of the future interest rate (round all entries
to the nearest peso).
(1) January 1, 2020
(2) December 31, 2020
(3) December 31, 2021
(4) December 31, 2022

ACCTG 106 PFRS 9: DERIVATIVES AND HEDGING Page 2 of 4

SOLUTION:

Critical information: To record payment to swap counterparty

Business risk exposure - Interest rate risk Derivative liability-IRS P10,000
Hedged item - Interest payment in Cash P10,000
2021 and 2022
Hedging instrument - Interest rate swap To record reclassification adjustment
Category of hedge - Cash flow hedge Interest expense (P/L) P10,000
FV adjustment G/L-IRS (OCI) P10,000
January 1, 2020
To record the change in FV of derivative
To record receipt of loan
Derivative asset-IRS P26,787*
Cash P1,000,000 Derivative liability-IRS 7,833
Loans payable P1,000,000 FV adjustment G/L-IRS (OCI) P34,620

To record the swap agreement *(P1M x .03 x 0.8929)

Memo entry

December 31, 2020

December 31, 2022
To record interest payment
To record principal and interest payment
Interest expense (P1M x .09) P90,000
Loans payable P1,000,000
Cash P90,000
Interest expense (P1M x .12) 120,000
Cash P1,120,000
To record the change in FV of derivative
FV adjustment G/L-IRS (OCI) P17,833* To record receipt from swap counterparty
Derivative liability-IRS P17,833
Cash P30,000
*(P1M x .01 x 1.7833) Derivative asset-IRS P26,787
FV adjustment G/L (OCI) 3,213
December 31, 2021
To record reclassification adjustment
To record interest payment FV adjustment G/L-IRS (OCI) P30,000
Interest expense (P1M x .08) P80,000 Interest expense (P/L) P30,000
Cash P80,000

PROBLEM NO. 4 (Interest Rate Swap – Fair Value Hedge)

On January 1, 2020, Entity P purchased a five-year bonds that has a principal amount of P100,000 and pays annually
fixed interest rate of 5% per year. Entity P classified the bond as available-for-sale. Current market interest rates for
similar five-year bonds are also 5%.

Because the interest rate is fixed, Entity P is exposed to the risk of declines in fair value of the bond. To eliminate the
risk of declines in fair value due to increases in market interest rates, Entity P enters into an interest rate swap on
January 1, 2020 to exchange the fixed interest payments it receives on the bond for floating interest rate payments.
Entity P designated and documented the swap as hedging instrument of the bond.

On December 31, 2020, market interest rates have increased to 6%, such that the fair value of the bond has decreased
to P96,535. Also on December 31, 2020, Entity P determined that the fair value of the swap has increased by P3,465.

REQUIRED:
Prepare the necessary journal entries in 2020.

SOLUTION:
To record the swap agreement
Critical information: Memo entry
Business risk - Interest rate risk
exposure December 31, 2020
Hedged item - Investment in bonds
(AFS) To record the change in FV of AFS
Hedging instrument - Interest rate swap FV adjustment loss-AFS (P/L) P3,465
Category of hedge - Fair value hedge AFS securities P3,465

January 1, 2020 To record the change in FV of derivative

To record purchase of investment Derivative asset-IRS P3,465

FV adjustment Gain-IRS (P/L) P3,465
AFS securities P100,000
Cash P100,000

ACCTG 106 PFRS 9: DERIVATIVES AND HEDGING Page 3 of 4

PROBLEM NO. 5 (Option – Cash Flow Hedge)
Dinalupihan Fitness Enterprises uses soybeans to make one of their nutritional supplement products. Dinalupihan
anticipates a need of 500,000 pounds of soybeans in November 2020. On September 1, 2020, Dinalupihan purchased
a call option for 500,000 pounds of soybeans on November 30, 2020, at a price of P40 per pound, which is the market
price on September 1. Dinalupihan paid P120,000 for the call option and designated this option as a hedge against
price fluctuations for their November purchase of soybeans. On November 30, 2020, when the prevailing market price
for soybeans is P45 per pound, Dinalupihan purchased 500,000 pounds of soybeans.

REQUIRED:
1. Make the necessary entries on Dinalupihan's books at
(a) September 1, 2020
(b) November 30, 2020

2. Assuming that the prevailing market price is P35 per kilo on November 30, 2020, make the necessary entries on
Dinalupihan's books at
(a) September 1, 2020
(b) November 30, 2020

SOLUTION:
To record receipt from counterparty
Critical information: Cash P2.5M
Business risk - Price risk Derivative asset-CO P2.5M
exposure
Hedged item - Highly probable forecast To record reclassification adjustment
purchase of soybeans FV adjustment G/L-CO (OCI) P2.38M
Hedging instrument - Commodity call option Cost of sales (P/L) P2.38M
Category of hedge - Cash flow hedge

REQUIREMENT NO. 1 REQUIREMENT NO. 2

September 1, 2020 September 1, 2020

To record the purchase of option To record the purchase of option

Derivative asset-CO P120,000 Derivative asset-CO P120,000
Cash P120,000 Cash P120,000

November 30, 2020 November 30, 2020

To record the purchase of soybeans To record the purchase of soybeans

Soybean inventory (500T x P45) P22.5M Soybean inventory P17.5M
Cash P22.5M Cash P17.5M

To record the change in FV of derivative To record the expiration of option

Derivative asset-CO P2.38M* Loss on call option (P/L) P120,000
FV adjustment G/L-CO (OCI) P2.38M Derivative asset-CO P120,000
*{[500T x (P45 – P40)] – P120T}

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